What Is Passive Income in Real Estate
May 22, 2022
Have you ever wondered what it would feel like to become a millionaire? Maybe you assume it could never happen because your 9-to-5 income stream would never allow it. But what would happen if you added to that income stream and earned passive income?
If you're wondering, "what is passive income and how do I earn it?" you've come to the right place. Let's dive in and see how you can generate passive income through real estate REITs and reach your financial goals.
What Is Passive Income
The name says it all - you earn income without working for it, but that's not entirely true. There is often some work or effort you must put in, but you do this upfront, allowing the money to accumulate over time.
Eventually, you don't have to do much to earn the income, but not all passive income streams are 100% passive. The key is to balance active and passive income so that you have multiple income streams coming in, helping you achieve your goal of financial independence.
One of the best ways to earn passive income is to find the best passive income investments. These are investments that earn money with little or no effort on your part, and they do exist.
The Difference Between Active and Passive Investments
As you learn the different ways to earn passive income, you'll encounter many active and passive real estate investing opportunities. Understanding the difference can help you create the right investment strategy.
Active investments require your effort and time. For example, if you buy rental properties and manage them yourself, it's an active investment. To earn income from a rental property, you act as the landlord, managing the property and the tenants.
On the other hand, passive investments only require that you invest money, and then the rest is handled for you. Examples of passive investments include real estate investment trusts and real estate crowdfunding. The most work you have to do to gain passive income is to research which investments are right for you.
Why Build Passive Income
If you are already stressed with your regular 9-to-5 job, you might wonder why you should put in more effort to earn money. However, with passive income, you're letting your money make money. It doesn't get any easier than that.
Why work harder than you have to when you can make more money by letting your money grow with minimal effort? Millionaires have seven streams of income, most of which are passive income streams. If your goal is to be a millionaire or earn even more income, passive income is the key.
Types of Passive Income in Real Estate
The good news is there are many passive income ideas you can use to generate income from real estate investments. Whether you want to invest in equity, debt, or own real estate outright, there are many passive real estate investment ideas.
Most people assume the only way to invest in real estate is to own rental properties, but others include indirect investments via the stock market or ETFs.
Keep reading to learn how to make passive income from real estate.
Real estate investment trusts are an up-and-coming way to earn real estate passive income. REITs are shares of a real estate company that you can purchase. The real estate company uses the funds to invest in either the debt or equity side of real estate, passing at least 90% of the profits onto its shareholders.
With a real estate investment trust, your only action is to choose which trust you want to invest in. The rest is done for you, so you are a real estate investor but collect passive income. The cash flow you earn could be from rental income as well as the capital gains from when the property is sold (hopefully for a profit).
Crowdfunding is another way to earn a passive income stream by investing in real estate. Rather than investing in a real estate company, you 'crowdfund' your money with other investors to invest either in a property's equity or debt (acting as the lender).
Like REITs, you invest money on a real estate platform. The platform does all the due diligence ensuring the investments are solid. They also grade each investment so you can choose the investments that fit into your passive income strategy.
Note investments are investments in debt. Rather than the real estate developer or the investor going to a bank to get funds, they come to individual investors like yourself. You generate passive income with the interest payments made each month and slowly collect your principal back with each monthly payment.
In this case, you indirectly receive passive income opportunities without needing to own any properties.
Real Estate Funds
If you want a 'traditional' way to invest, you can buy real estate funds which are mutual funds that focus on the real estate industry. You can choose from actively or passively managed funds, and most real estate funds invest in REITs and other real estate companies.
The difference between REITs and real estate funds, though, is the lack of cash flow from real estate funds. You typically won't receive monthly rental income like you would with REITs, and passively managed mutual funds usually mimic a specific index.
Hard Money Lending
Hard money lending helps real estate developers and investors who couldn't get financing from a financial institution get the funds they need. Hard money lending is riskier but often has a high rate of return.
Most developers and investors borrow hard money loans for the short-term, usually 6 - 12 months. There's a risk of a total loss if the borrower defaults on the loan, but since the property is the collateral, you can make some money back.
Fractional Real Estate
Fractional real estate investments are another way to get into real estate investing without needing a lot of capital. When you're a fractional owner, you own a percentage of a property with other investors, sometimes hundreds of them.
Fractional real estate isn't completely passive income, though, depending on how you own it. As part of a real estate group, you and the other investors will need to hire a property manager, decide how the property will be used, and decide on any property-related decisions.
As a fractional owner, you are generating passive income from your percentage of the rental income plus the appreciation earned in the property as it increases in value.
If owning investment property in your local area is outside your budget, you can invest in real estate remotely outside of your area. Of course, this takes a leap of faith and some blind trust, but with the right property manager, real estate agent, and contractors, this could be one of those 'think outside of the box' passive income ideas.
To invest in remote ownership, you'll need to view properties virtually. This works best when you have a reputable real estate agent helping you choose the right property. If you have an upfront investment but need financing, you can secure financing online and even close the loan online.
The final step is to hire a property management company to handle tenant screening, choosing tenants, collecting rent, maintaining the property, and handling any problems while you sit back and collect a passive income.
If you want a low-risk way to invest in real estate and earn a passive income stream, consider ETFs or exchange traded funds. ETFs are baskets of investments in a niche, such as real estate. They might include stocks, bonds, and commodities, diversifying your investment in one fund.
ETFs are passively managed, so the fees are low, but you can earn passive income with the dividends paid out. You can choose to reinvest your dividends or cash them out and use them to supplement your income.
Peer to Peer Lending
Peer to peer lending is a form of mortgage financing offered by an individual investor instead of a bank or lender. Peer to peer lending platforms have a due diligence process that they use to accept or decline potential loan opportunities, and they grade each loan so you can choose the investments that meet your risk tolerance.
You can usually invest as little as $10 in each loan to diversify your funds and earn a passive income stream from the interest payments on each loan.
Some passive income ideas allow you to invest in businesses versus individuals, such as private equity investments. As a private equity investor, you provide the funds or some of the funds for business ventures to get up and running. For example, you might help a new business start or help an established business grow.
Usually, when you invest in private equity, there is an agreement on how you'll get paid that includes the rights to future income earned by the business. This way, you earn passive income investing in a business without running it yourself.
Risks vs Rewards of Passive Investment
Passive income ideas are a great way to earn money, but there are risks and rewards like any investment.
All investments have risks. There's a risk of default if you invest in the debt side of real estate and a risk of an asset not appreciating if you invest in the equity side. Even some of the best passive income ideas put your money at risk.
The key is to diversify your investments to lower your risk of total loss. Don't put all your eggs in one basket. Instead, invest in some active income and some passive income ideas. You could also diversify your investments across many passive income investments such as dividend stocks, a high yield savings account, money market fund, REITs, mutual funds, and peer to peer lending.
There's a reward side to most passive income streams like any investment. The higher an investment's risk is, the higher the rewards, but again, having a diversified portfolio will help you maximize your rewards.
There's no guarantee that every passive income investment will provide you with a return, but you can create passive income with the right level of diversification.
How Is Passive Real Estate Income Taxed?
Most passive real estate income is taxed by the internal revenue service at your ordinary-income tax rate. This tax treatment does mean passive income can increase your tax liabilities or even increase your tax bracket depending on how much you earn. It's always best to talk to your tax advisor about how it might affect your taxes, especially if you expect significant income.
How Much Can You Make From Real Estate Passive Income?
No investment is guaranteed whether you invest in the stock market, physical real estate, or commodities. No one can predict how it will perform. How much you can make depends on the type of investment you make, whether you invest in income producing securities or rental income producing securities, and what risks you take.
You'll typically have much better returns than you'd get from investments like high yield savings accounts, but even passive income ideas require diversification and a plan if you lose money.
What is passive income? Now that you have the answer it's time to add it to your portfolio. Letting your money grow for you is the key to reaching your financial goals. Since there's only so much time and effort anyone can put forward to earn active income, adding passive income streams to your portfolio may help your money grow faster. Learn more by signing up and visiting our blog.
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